FinCorp has issued both common and preferred stock. FinCorp\'s common stock just

Question

FinCorp has issued both common and preferred stock. FinCorp's common stock just paid a $1.70 divided and its current price is $ 22 per share. The common divided is expected to grow at a constant rate of 5% per year. FinCorp's preferred stock pays a perpetual $8.80 annual dividend and sells for $98.25. The preferred stock price is expected to remain constant in the foreseeable future. What it is the 1) expected total return on FinCorp's common and preferred stock. 2) expected divided yield on FinCorp's common and preferred stock. 3) expected capital gains yield on FinCorp's common and preferred stock. Thanks!

Explanation / Answer

1) Common Stock

P0 = D1 / (r-g) = D0 (1+g) / (r-g) = 1.70(1+0.05) / (r- 0.05)

22 = 1.785 / (r-0.05)

r= 13.11%, where r is the expected total return on common stock

Preferred Stock

P = D/r'

98.25 = 8.80 / r'

r' = 8.96% , where r' is the expected total return on preferred stock

2) Dividend Yield

Current dividend yield for common stock = dividend paid/ price = $1.70 / $22 = 7.73%

Preferred stock, dividend yield = $8.80 / $98.25 = 8.96%

3) Expected capital gains = Price at which stock is sold - price at which stock is bought / (price at which the stock is bought)

For common stock if P' is the selling price and it is bought at current market price of $22/share then capital gains = (P' - 22 / P')

For preferred stock the capital gains is equal to zero since its price is assumed to reamain constant in the foreseeable future.

4) Common stock are more risky as compared to preferred stocks, since their can be -100% capital loss on common stock unlike preferred stock where the investor usually gets the face value back. Also preferred stock holders are given dividends before the common stock holders and in case of less profits preferred stock holders may get dividend while common stock holders may not.

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